Jay Bryan: Japan upturn no flash in the pan

Jay Bryan, The Gazette06.13.2013

A man looks at an electronic stock board of a securities firm in Tokyo Friday. Japan’s Nikkei 225 index gained 1.9 per cent to close at 12,686.52 as Asian stocks rebounded Friday from Tokyo’s sharp decline after investors were encouraged by positive U.S. economic news.

MONTREAL — In the West, we think things have been tough over the past few years. We’re right, of course, but it could be much worse. Just look at Japan, whose bubble economy, built on inflated real-estate and stock prices, imploded 23 years ago and still hasn’t recovered.

This is important to us because Japan is a more important factor in the world than we sometimes realize. Its economy remains the third-largest in the world, influencing markets for petroleum and other important Canadian exports. Its stock market accounts for a big chunk of the international equities found in our investments and pension plans.

That’s why it’s such good news that a new Japanese government led by Prime Minister Shinzo Abe has presided over such strong signs of recovery. But it’s also worrisome that this revival shows signs of being cut short.

Happily, a careful look at Japan’s fundamentals offers good reason to believe that the past few weeks of crashing prices on the Nikkei 225 index, a widely watched barometer of equity-market prices, is more likely a financial-market hiccup than another descent into economic purgatory.

The background is this: once Abe came to power, he quickly announced a sweeping program of reforms to revitalize Japan’s dormant economy, beginning with ultra-easy monetary policy — a little like the playbook of Fed chairman Ben Bernanke. The goal was to end the country’s disastrous deflation and bring about moderate inflation in wages and prices — a necessary environment for healthier economic growth.

Abe promised that easier money would be reinforced by fiscal stimulus in the form of government spending and by deeper economic reforms that would open up uncompetitive sectors of the economy to boost economic growth permanently.

Monetary easing was the quickest change to take effect and worked spectacularly, helping propel an 80-per-cent jump in stock prices from late last year, but Abe’s economic reforms, detailed on June 5, proved to be disappointingly modest. This likely worsened a sharp fall-off in stock prices that began late in May and has now wiped out about half of the earlier gains.

Commentators all have theories about this swoon: it’s because of fear that monetary easing will be ended before it’s gone far enough or because Abe’s reforms, useful as they may be, are not deep enough to maintain his credibility as an agent of change. A common thread is that the new optimism about Japan was a mistake.

Maybe, but given the underlying facts, the conventional wisdom seems excessively pessimistic.

For a start, a stock pullback is quite typical after a blazingly fast run-up in prices. Stock markets are vulnerable to any shift in investor optimism, which is a notoriously volatile and inaccurate predictor of the future. Thus markets very often take two or three steps forward, then one or two steps back.

If you look at more basic indicators of Japan’s health, though, the picture looks better. A broad measure is growth of the economy in the first quarter, which first surprised analysts by blowing far past their expectations, and has since been revised even higher, to the very robust pace of 4.1 per cent.

The speed-up in economic growth was supported by healthy gains in consumer spending, a critical element in any economic recovery. Recent developments suggest this could continue. Japanese consumer confidence increased in May, while the latest monthly data on wages showed the biggest jump in the past year.

Even more persuasive, Japan’s political landscape is changing fundamentally as voters react to 23 years of unending job insecurity, stock-market declines and soaring inequality between haves and have-nots. This ensures continued political support for Abe’s populist program of basic reforms, argued analyst Jim Mylonas of BCA Rersearch in a report last December that predicted many of this year’s key developments, including monetary easing and stock market gains.

This intense pressure for change makes it highly likely that Abe will forge ahead in coming months with further reforms — which will be reflected in new equity gains for some time to come, believes BCA’s chief geopolitical strategist, Marko Papic. It’s hard to argue with him.

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